Tuesday, June 17, 2014

Valeant Pharmaceuticals Part VI: a first question on corporate jets

A simple question. Is any part of the four (?) corporate jets ever put into the one-off basket like royalties (which were continuing) for Galderma?

For reference - future post coming - this is the largest corporate jet. It is basically the fastest, longest range and most expensive corporate jet on the market. It is a Gulfstream 650...

PS: There were denials (plausible) of many of my assertions in the conference call. However they simply admitted the piece about the royalty paid to Galderma. They accrued a liability for ROYALTIES on Galderma and wrote that royalty off against current earnings thus raising the "cash EPS" during that period.

Given they are selling the product they are going to reverse the rest of that liability through the purchase price. [Simply they will not receive the whole purchase price in cash - some of it will be cancelling a liability they have accrued.]

12 comments:

Anonymous
said...

So now you are left complaining that a CEO has borrowed against a 100% personal account position (oh no what a crime). As a point of reference what is your largest personal position size? And that a a $40 bill company has a few business jets. Another shocker. As a habitual reader of your blog, it seems like you are being led by other than rational instincts here.

Just a complete guess, I could be totally wrong, but they purchased that very plane, or a similar one, and given their extremely small capex, you can't figure out where it fits on the cash flow statement and income statement. Or perhaps, that plane was acquired by one of the company's targets just before consolidation?

John – Using corporate jets may be distasteful to some, but it doesn’t seem to advance the short argument to me. The proxy clearly discloses that Pearson uses the plane for business and personal use (as does his family). Perhaps you have more to say.

The pledging issue deserves more disclosure/explanation from the Board and Pearson.

The reliability of “cash” EPS and the sustainability of products after VRX acquires them are areas that deserve scrutiny. In my mind, these are 2 areas where some roll-ups play fast and loose and the areas shorts seem to focus on (as you have done). In the case of VRX, I think most long-term holders devote a lot of time to these areas. You’ve made some good points with your posts, but I think VRX addressed some of them with their slide deck today. (as an aside, I’d like to know how many companies whose stocks you’ve shorted have actually tried to clearly address short arguments and have agreed to improve disclosures as a result?)

We can go back and forth about the usefulness of VRX’s “organic” growth numbers, but my view is that for the most recent deal, Bausch&Lomb, that it’s too soon to tell whether VRX’s cost cuts will hurt long-term product growth. Also, I’d note that US brand pharma is unique in that companies have very strong pricing power. So, many of the early VRX deals worked in part because VRX pushed price much higher after the deals closed. A common tactic in US pharma.

If free cash flow in 2q14 and 3q14 is higher than in 1Q14 AND the delta between GAAP and cash EPS shrinks (as it should, in the absence of major M&A) would you believe your argument loses steam? What evidence would cause you to change your mind?

Finally, when you started these posts I expected you to address the issue of VRX’s tax rate. To me, this was always the hardest aspect of the business to get comfortable with (but perhaps also the most difficult to do independent work on). I’ve looked at lots of pharma companies, both US and non-US domiciled, and VRX has by far the lowest tax rate. It’s not clear to me what drives this -- I know what VRX mgmt says about issuing debt in the US as a tax shield and moving IP offshore, but I still worry about this issue. If I had to guess I’d say that VRX is more aggressive with transfer pricing than other companies and assigns all profit to the intellectual property (not sales, marketing, etc) which is owned outside the US. Interested to see whether you’ve found anything damning related to tax rate.

Even if you are wrong, and there is not yet conclusive evidence to make a determination either way, I think the questions you have posed are reasonable and look forward to the finished product. It is rare that an investor of your caliber provides these types of insights about a thought process and I am grateful.

Valeant can't keep buying companies forever. Companies will fight back (i.e., Allergan) or they may run into competitive issues with regulators, which will limit their size, or other large pharma companies will compete with Valeant in M&A opportunities.

Thus, we will eventually get to a point where we will start to get apples-to-apples year/year comps on sales performance. And if trends (i.e., revenues) decline, cash flows will decline as well and credit metrics will worsen.

This means that it will be harder for Valeant to service its debt (cash interest payments in light of decline cash flows), and more expensive for Valeant to refinance its debt (due to worsening credit metrics). If Valeant cannot refinance its debt the Company will have to sell assets to raise cash to pay off debt. All of which will drive equity valuation down. Interest rates will most certainly be higher when Valeant needs to push out debt, meaning higher cash interest payments. In this scenario, it will be difficult for Valeant to recover because they would have to restart the roll-up strategy, but in light of the above, will they be able to acquire other companies? Will the leverage be sustainable? Or they can invest in their business (i.e., capex...which Management doesn't believe in), but that will have to be funded from somewhere.

John, few people short strictly on poor fundamentals or an unsustainable business model. Hopefully you have identified some catalysts in the near-term. For me, I will be doing more work once the debt complex trades below 90. Very interested to see how this plays out.

Just a quick note--John, I really appreciate your posts, and not just because I have come up with similar conclusions in my work in which I have also steered my clients away from Valeant. But enough about me--which really is the point of my comment. I also appreciate your profound patience with many of the posters here. I mean WOW. And to the serial poster Anonymous, I would appreciate if you would remember that this is John's blog--not yours. I enjoy your work in Seeking Alpha, but when I come here I want to hear from John. I have some interest in the potentially enlightening debate that may arise via the comments section--but NOT to have to wade through your increasingly long winded pontificating, especially since you unfortunately have adopted a more caustic and inappropriately familiar tone in your posts lately. Just saying.

N650CK was built for Calvin Klein obviously. He took delivery for a few months through a holding company, but I guess N600CK was good enough. With the technicalities and Calvin being such a good Gulfstream customer, they seemed to have looked the other way when he flipped the jet for a $10+m profit to Valeant so their CEO could fly in the best of them (hopefully Valeant is on the list for the Global 7000 or 8000 so they don't have to overpay $10m next time!). Gulfstream says flipping jets WILL NOT be allowed and will VOID the warranty (including on the Rolls-Royce turbo fans), but I guess taking delivery first isn't flipping, especially if you're a long-time Gulfstream customer.

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